'Cold War' heats oil market

Sam FletcherSenior Writer

Crude futures soared above $120/bbl Aug. 21 on the New York market for the first time in 2 weeks as both the US dollar and US-Russian relations deteriorated. In the Houston office of Raymond James & Associates Inc., analysts suggested "a new Cold War" might be "heating up the oil market" apparently due to US opposition to Russia's incursion into nearby Georgia.

That same day at Petromatrix in Zug, Switzerland, Oliver Jakob noted "Ten days ago, the Baku-Tbilisi-Ceyhan oil pipeline was on fire, bombs were falling on Georgia, the US [crude] stocks were reported lower than expected, but the price of oil was moving down. Today the BTC pipeline is repaired, no shots are fired in Georgia, the US stocks are reported higher than expected, but the price of oil is moving up. The difference between then and now is of course the directional move of the Dollar Index and assets allocation linked to it." BP PLC, operator, said shipments of Azeri crude would resume via the BTC pipeline by the end of August.

Moreover, Jakob said, "We do not buy the argument that explains yesterday's [price] move by 'geopolitical concerns.' Russia has taken care not to bomb the BTC pipe in its Georgian intrusion, and it has enough leveraged arguments to use against the West (northern access to Afghanistan, veto on 'Iranium') not to have to use the oil tool." He added, "The US envoy to the North Atlantic Treaty Organization claims that on the eve of the Georgian assault on Ossetia, [western officials] were again telling them not to do it as they would fall into a Russian trap. Georgia apparently did not listen, and despite all the current face saving, not all NATO nations are extremely happy to have been thrown in the trap and put their relations with Moscow at risk of this uncontrolled adventure." Meanwhile, Russia suspended military cooperation with NATO due to the dispute over its incursion into Georgia.

OPEC output cut?That same week, Paul Horsnell, Barclays Capital Inc., London, warned that the Organization of Petroleum Exporting Countries "is now heading for an output cut, and potentially a very large one" at its Sept. 9 meeting. "Only a price rally back to well above $120/bbl is likely to be able to halt a substantial removal of OPEC crude output from the market," he said.

While rising in euro terms, the value of the OPEC basket in late August sank to the lowest dollar figure since early May. "Given the speed of recent falls," Horsnell said, "a move below $100/bbl for the value of the OPEC basket would represent a matter for major concern for most of the key ministers, and a move below $90/bbl would be likely to be considered as something of a crisis. Indeed, at current price levels or lower, we would see it as inevitable that OPEC will seek to reduce its output and its target ceiling at the September meeting."

The August oil market report from the OPEC Secretariat "states that the risks to the outlook are on the downside, that non-OPEC output is about to surge, that OPEC is already producing well above the call on its crude, that the demand outlook is worsening, that the global economic situation is deteriorating rapidly, and that speculators are now short," said Horsnell.

"We think the secretariat is being a little pessimistic about demand and, most importantly, is factoring in a wave of non-OPEC supply growth that is likely in reality to disappoint," Horsnell added. "However, that does not detract from the view that the cautious strategy of least regret for OPEC is to cut, and possibly to cut very hard."

Should crude futures prices stabilize around $120/bbl, Horsnell said, "then a cut is less likely." Should prices linger lower, he said, "then a cut in actual output is fairly certain, and should prices fall further, then the target ceiling and actual output are both likely to come down sharply, in our view. However, whatever the price dynamics in the coming weeks, at this point another meeting in October or at the latest November now looks to be fairly likely."

Meanwhile, he said, "The US market continues to trim both its products surplus and its crude deficit, and indeed looks likely to flip into the reverse pattern. Gasoline demand has held above 9.4 million b/d for a fourth week, and is lower year-over-year by a mild 1.5% for August to date."